Seeing the Fire Behind the Smoke

Jul 01, 2011

Todd C. Davis
In today's market nothing is standard. The partnering landscape has become more pressured, competitive, and complex in terms of deal structure. But business development and licensing executives should not overlook certain license terms and conditions once the economics have been finalized. In fact, it is often boilerplate language or lack of common-sense terms that can derail or hinder the use of licensed assets and influence their long-term value.

Licensing is a mainstay of biopharmaceutical companies and academia. Over 600 deals valued at approximately $25 billion were announced in 2010, and these numbers will continue to grow as large pharma increases its reliance on in-licensed technologies and new molecular entities to fill pipeline gaps. To maximize the value of intellectual property (IP) and not leave money on the table requires vigilance. While crafting license agreements involves all of the tactical tradeoffs expected in a negotiating dynamic, one should try to pay attention to these 10 licensing pitfalls:

1) Limited ability to assign or grant security interest in the license. Many years after the license is signed, when the product is being marketed and the licensor has moved on to other pursuits, the license agreement may well be considered a non-strategic financial asset. But with any financial asset, the more restrictions that exist, the less valuable it is. A license agreement that cannot be assigned (including assignment of the right to receive royalties), or one that cannot be pledged as collateral, is at a serious disadvantage if the holder wants to sell downstream. By clearing these hurdles upfront, the license agreement will be both more marketable and more valuable.

2) Complex and unclear royalty terms. Uncertainty reduces the value of any asset. It's the "ifs, ands, or buts" in these agreements that make it hard to decipher how much money is due and when; what seems clear to those who hammer out the deal can often be confusing years later. At a minimum, the license should clearly specify the royalty rate, how it is calculated, when it will be paid, and for how long. It seems like common sense, but clarity is critical when assessing how much the asset is worth.

3) Maintaining third-party royalty obligations. This can be a significant liability for a licensor, unless the contract explicitly makes them the obligation of the licensee. In the worst case, if the licensee were to stop paying royalties and the agreements don't appropriately address the issue, the licensor could still be on the hook for royalties due to any third-party royalty holders. These obligations can also complicate and ultimately impact how much money the licensor takes home. Once all the royalty payments have been calculated, a licensor's net percentage could be significantly less than the original forecast. Third-party obligations should be assumed by the licensee.

4) A narrowly defined royalty payment term. It is important to look at not only the patents to be licensed, but also at the underlying value of what is being transferred as part of the agreement. Leaving the know-how or other components unaccounted for can leave the innovator empty-handed after delivering significant value. Take, for example, a license that ties specifically to one cell line. The licensee ultimately changes cell lines but still uses the additional art and know-how transferred as part of the deal. Unless the license requires payment for the know-how, the licensor will receive no royalties. Define the components of that value as broadly as possible.

5) Lack of information rights. A license for commercialized technology is one of a licensor's most important assets. Access to key pieces of information during the development and commercial stages is imperative. In the development stage, it is important not only to be able to validate how things are progressing but, at the most basic level, that the product is actually being developed. Once the product is on the market, it is critical to be able to validate the calculation of the royalty rate and estimated payments. Royalty reports by geography, audit rights and reports, regulatory information, and license communications will give a licensor the tools to do this and are indispensable parts of a well-crafted license agreement.

In addition to having access, a licensor needs the ability to share this information confidentially with a potential acquirer or investor. Without that right, it will be impossible to fully realize value for this license downstream. Establishing these rights out of the gate will provide greater autonomy over the long term.